Islamic working capital finance covers the gap between a company's operating outlays, such as purchases and production, and the collection of its sales, using contracts backed by goods, orders or a share in results, without an interest-bearing loan.
Measuring the gap before seeking finance
The working capital requirement is calculated as inventory plus trade receivables minus trade payables. An SME holding 60 days of stock, collecting at 45 days and paying at 30 must finance 75 days of turnover; that is the volume the contracts will have to cover.
Splitting the cycle into three fundable stages
Islamic finance does not fund an abstract balance but identified transactions. So the purchase of inputs, the manufacturing or storage period and the wait for customer payment are separated, each potentially using a different contract with its own rules on possession and price.
A worked example for a furniture maker
A workshop with annual turnover of 1.2 million and a 75-day requirement ties up about 250,000 permanently. It can cover 150,000 through a Murabaha facility on timber and the rest through Istisna contracts backed by firm orders from business customers.
Seasonality: matching the limit to the calendar
A cannery buys most of its tomatoes in summer and sells all year round. Instead of a fixed limit, the bank can open a facility whose amount rises before harvest and falls as sales come in, each drawing remaining a separate transaction.
Inputs and raw materials: letting the bank buy
For the first stage, the bank itself buys the fabric, steel or packaging from the supplier, then resells it to the company at a marked-up price payable in 90 or 120 days. The credit period obtained should match the actual length of the cycle, not exceed it.
Appointing the company as purchasing agent
In practice the bank often appoints the customer to buy on its behalf. AAOIFI standards then require the bank to bear the risk between purchase and resale, and the company to notify the acquisition before the second sale is concluded.
Preventing one invoice from being used twice
When a company makes many drawings, the bank checks that each supplier invoice supports only one transaction and that the goods had not already been paid for. Checking invoice numbers and delivery notes keeps the financing from becoming a mere cash advance.
Paying suppliers in foreign currency: what changes
If inputs are imported in dollars, the bank pays the supplier in that currency and resells in local currency at a price fixed in advance. The company is thus protected from exchange-rate movements on that transaction, since its debt is set at signing.
Made-to-order production: Salam and Istisna
For the manufacturing stage, Istisna lets the bank buy a product yet to be made and pay in instalments as production advances. Salam, paid in full upfront, suits standardised goods such as grain, cotton or certain industrial products.
Running Musharaka: sharing the cycle's result
Used notably in Pakistan under the name running musharaka, this formula brings the bank into the business in proportion to its utilised balance. It receives a pro-rata share of operating profit, usually capped, and bears its share of any losses.
Investment Wakala over a portfolio of trades
The bank can also entrust funds to the company as an agent tasked with buying and reselling goods. The agent earns a fee and may keep any surplus above an expected return; it does not guarantee the capital, except in cases of misconduct or negligence.
The role of the Islamic Development Bank and ITFC
Established in 2008 within the IsDB Group, the International Islamic Trade Finance Corporation funds imports of inputs, often through Murabaha, for companies and banks in member countries, particularly for energy and agricultural products.
Specialist external source
The Islamic Development Bank and its trade finance subsidiary describe their facilities for companies and banks in member countries, including the financing of inputs and exports.